Carbon trading: Money from (clean) air

The emerging trade in carbon credits is gaining more impetus and India, being a developing country, qualifies to be a host country for Clean Development Mechanism projects.

C. Rajalakshmi

‘Clean money for dirty air’. That’s the premise of an emerging trade in carbon credits, which is gaining more impetus with increase in the number of Clean Development Mechanism (CDM) project ideas approved by the National Clean Development Mechanism Authority.

The value of the carbon trading market was around $30 billion in 2006 as per the estimates of the International Emissions Trading Association.

Since 2002, a cumulative 920 tonnes of carbon dioxide equivalents have been transacted through CDM project activities. European buyers dominate the market, with 86 per cent market share as of 2006. On the selling side, India leads the race with 288 CDM projects registered followed by China with 129 projects as of November 2007.

Where India stands

With Indian economic growth based mainly on energy from fossil fuels such as coal, there is considerable potential for reducing greenhouse gases and for CDM projects.

Of the 839 CDM projects registered with the United Nations Framework Convention on Climate Change (UNFCCC) as of November 2007, 288 projects are in India, giving it a global share of 35 per cent (Source: UNFCCC statistics).

Listed Indian companies are already reaping sizeable profits through Certified Emission Reduction (CER) deals. The UNFCCC issued 1.83 million CERs to SRF Ltd in February 2006 for its HFC-23 thermal oxidation plant.

Following this there was a surge in its net profit in the third quarter (December 2006) due to an inflow of Rs 122.28 crore from the sale of CERs. This was nearly 27 per cent of the total income that year.

Tata Sponge Iron Ltd got a CDM certificate from the UN for its waste heat recovery project in Orissa. The company expects to reduce 3,17,624 tonnes of carbon dioxide over a 10-year period. JSW Steel’s plant in Karnataka has got clearance for its carbon credit project and is expected to earn 7.67 million CERs over the next 10 years.

All these CERs could be traded in the market, which would provide potential income over the next few years. Gujarat Fluorochemicals, Gujarat Ambuja Cement, Birla Corporation Ltd, Balrampur Chini Mills, Tata Steel and JK Cement are also eyeing additional profits through the CER route by 2012. Reliance Energy already has energy efficiency and process development CDM projects and is now looking at natural gas-based power plants.

Why Carbon trading?

Something that began as an effort to drive away greenhouse gases from the atmosphere has paved the way for a business opportunity. The Kyoto Protocol, adopted in 1997 to reduce greenhouse gases that cause global warming, came into force in 2005:

The protocol has been ratified by 175 countries, including those in the European Union, Japan, Canada and Russia.

This has set legally binding targets for the countries to reduce their greenhouse gas emission by 5.2 per cent, from the 1990 levels, by 2012. This protocol provides three mechanisms to developed nations to meet their emission targets:

Joint implementation among the developed nations: Allows industrialised countries with a greenhouse gas reduction commitment to invest in emission reducing projects in another industrialised country as an alternative to emission reductions in their own countries.

The Clean Development Mechanism provides developed nations with CERs for implementing carbon emission reduction projects in developing nations.

Developed countries can use the CERs generated by such projects to meet their emission targets under the protocol.

Emission trading among the developed nations under which a central authority sets a limit or cap on the amount of a pollutant that can be emitted. Companies or other groups that emit greenhouse gases are required to hold an equivalent number of credits or allowances representing the right to emit a specific amount. The total amount of credits cannot exceed the cap, limiting total emissions to that level. Companies that need to increase their emissions must buy credits from those which emit less.

The Business Opportunity

India being a developing country qualifies to be a host country for CDM projects. The Institute for Global Environmental Strategies estimates the potential for CDM projects in India to be about 300 million tonnes of CO{-2} equivalent, which includes 90 million tonnes from renewable energy sources alone.

CDM projects do not just include emission reduction projects but also afforestation and reforestation schemes. These projects generate tradable emission credits. The European Climate Exchange (ECX), the Chicago Climate Exchange and the Asia Carbon Exchange are places where these credits change hands. To navigate these markets, Indian companies rely on offset aggregators, climate change consultants and banks.

The aggregators bundle smaller offset projects to apply for carbon credits when the projects are individually too small for registration. The verifiers are technical hands who validate the credibility of the project at the field level. Consulting companies such as Eco Securities help in registering and validating the CDM projects.

Once the project is validated, the banks come in and facilitate buying and selling of CERs on behalf of their clients. A number of banks have invested in special divisions and experts. The State Bank of India has one and, recently, IDBI tied up with KfW Bankengruppe, Germany, to set up a CDM portfolio in India.

How it is traded

The CER is sold at a price negotiated between the buyer and the seller. Currently, Indian sellers are able to realise 15-20 euros on an average per CER. The major factor affecting the price of CER is the EUA (European Union Allowance) market price. EUAs refer to the secondary market for CERs where the buyer purchases emission allowances created and auctioned by the regulators.

Here the CER is offered with a guarantee of delivery by the regulator. Project and delivery risk is borne by this entity in the secondary market. CERs often command a higher price than those bought directly from a project. Future and Option contracts on these EUAs are traded in ECX and are experiencing increasing growth.

Since launch in April 2005, the EUA futures contract has seen close to1.3 billion tonnes CO{-2} traded with an underlying market value of 24 billion euros. ECX will also shortly introduce futures and options contracts on CERs.

The Worries

In the fragmented carbon marketplace, efforts to mitigate carbon are multiplying. There is substantial potential in India to achieve emissions reduction. The only factor that has impeded the setting up of a carbon trading exchange in India is the lack of a regulator to monitor the trade.

Adding to this, the government is also yet to decide on whether carbon credit is to be traded as a commodity or financial instrument. From the global perspective, the uncertainties are with regard to what would happen after 2012 when the first phase of the protocol comes to an end.

The other important point that we cannot afford to miss out is the US, the largest emitter of GHGs, being out of the protocol’s ambit. But still there are wide expectations that the US would undertake emission cuts. If this becomes a reality, then Indian companies could rake in huge fortunes.

(This article was published in the Business Line print edition dated November 18, 2007)

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